1. 4. public choice in a representative 2. origins of the ...public+choice/public... · democracy...

© Freytag 2015 1

4. Public Choice in a Representative

Democracy

I. Federalism

a) The logic

b) Why is the size of the government too

large?

c) Why is the size of the government too

large and to small?

II. Two-party competition and deterministic voting

a) Outcomes in the Hotelling-Downs-Model

b) Two-party competition in a constrained

policy space

c) Two-party competition (probabilistic

voting)

1. Introduction

2. Origins of the State

3. Public Choice in a Direct

Democracy

4. Public Choice in a

Representative

Democracy

5. Application of Political

Economy Models

6. Normative Public

Choice

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III. Multi-party-Competition

a) Selecting a representative body

b) Proportional representation in practice

c) Electoral rules and the number of parties

d) Goals of parties

e) Cabinet stability

f) Strategic voting

IV. The paradox of voting

a) Rational voter hypothesis

b) Expressive voter hypothesis

c) Ethical voter hypothesis

d) Voting as duty

V. Rent seeking

a) The basic model

b) Rent seeking through regulation

c) Rent seeking through tariffs and quotas

d) The logic of collective action

e) The costs of protection

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VI. Bureaucracy

a) Budget maximization

b) Price-setting behavior

c) Slack maximization

d) The power of the agenda setter

e) The government as leviathan

f) Regulatory capture

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Introduction

Whereas in a direct democracy, problems of lobbying

and administration do not play a major role, in a

representative democracy they do.

Principal-agent-problem

In a representative democracy, public choice analysis is

even more adequate, as a political market can clearly be

observed. On this market, political entrepreneurs try to

sell their product, and rent-seeking groups express their

demand.

There are different levels of decision-making. This

constitutes more difficult problems.

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I. Federalism

Federalism can be interpreted as an application of the

theory of clubs.

The assignment problem under federalism is not about

the horizontal assignment of responsibility for e.g.

monetary policy, fiscal policy, industrial relations etc (see

below). Rather it is about the assignment of policy

responsibility to different levels of decision-making.

Following the Tinbergen-principle, each policy goal

needs an individual instrument.

Neoclassical assignment adds the requirement to have

an individual agency for each objective.

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The assignment problem

Objective Instrument Agency

growth fiscal policy govt.

stable prices monetary policy ECB

employment wages unions/

empl.

a) The logic

A simple example may illustrate the point.

Consider a community of nine, divided into sub-

communities of three, A, B and C. Two public goods,

GF as the federal and GL as the local public good, are

to be provided.

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First assume the both, GF as the federal and GL as the

local public good, are provided centrally under majority

rule.

A1 A2 A3 B1 B2 B3 C1 C2 C3

Under Plott’s theorem, B2 is the median and the amount

of both GF and GL will be provided.

In the case of the federal public good, all have to

consume the chosen level.

In the case of the local public good, the groups A, B and

C would prefer a different outcome. They would chose

A2, B2 and C2 respectively.

GF, GL

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Group A would consume less of the local public good GL,

whereas group C would like to have more of it.

The superior solution would, therefore, be to assign the

responsibility for GF to the larger community and for GL to

the local communities.

Federalism has two salient properties (compare: FOCJ):

• separate and overlapping levels of government,

• different responsibilities at different levels.

Obviously, federalism has its limits. There are least

classes of public goods provided on the same political

level, and the number of levels must not be too high; the

reason being

transaction cost.

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Geographic representation vs. at large

representation

Geographic representation implies that each local

community sends one (or more) representatives to an

assembly of the higher level of government.

At large representation implies that all voters select their

candidates for the higher governmental level from one

single list.

There is not necessarily a consideration of the regional of

local minorities, depending on the individual voting

behaviour.

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b) Why is the size of government too large under

federalism?

Log-rolling!

Under local responsibility, group A will consume less the

local public good GL than groups B and C.

If B and C form a coalition to provide GL within the large

community, they can reduce their tax per capita at the

expense of A.

This scenario happens under geographic

representation.

It may be different under at-large representation.

Log-rolling may hit back in the future universalism!

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Intergovernmental grants under federalism

Is there a justification for grants from one governmental

level to another (normally top down)?

Positive externalities, example state highway (US), used

by citizens from all US states.

A federal grant then is a Pigouvian subsidy, financed e.g.

through lump sum taxes.

What are the effects of …

• a matching grant (Figure 4.1);

• an unconditional grant (Figure 4.2);

• an earmarked grant?

Grants can also be justified by financial differences

across communities.

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U2

U1

B

B

B‘

GMG

G0

X0

X

G

E

F

G

EF – substition effect

FG – income effect

Figure 4.1: The effects of matching grants1. Introduction



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B

B‘

B B‘X0 XUG

GUG

G0

B‘‘U1

U2

X

G new budget constraint: BB“B‘

EF income effect, no substitution effect

E

F

U4

U5U3

switch U3 U4 not possible

switch U3 U5 possible

Figure 4.2: The effects of unconditional and earmarked

lump-sum grants1. Introduction



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Empirical evidence is contradicting the basis hypothesis

as derived from Figure 4.2: Both unconditional and

earmarked grants should be divided into an increase of

the public good and more private consumption or savings

(e.g. via tax reduction).

Flypaper effect: federal money sticks where it

lands, in the local governmental budget!

Reasons:

• fiscal illusion;

• bureaus tend to maximise their budget

(Niskanen 1971);

• an earmarked grant is treated like a matching

grant.

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c) Why may the size of government be too large and

too small under federalism?

Assume a two level state with a government only striving

for re-election; a very simple model where median voter

theorem does not hold.

In the model, spending money increases the probability

of re-election, raising taxes decreases it

Under geographic representation, two public goods are

in the calculus of the government; GL and GF.

As a result of the optimisation process, the government

provides GL on a more then optimal level and GF on a

less than optimal one.

Figure 4.3 a) and b).

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0 GG G0L

GGL

GL

MCL

MCGL

MVL, MCL

0 GG GGFG0

FGT

F

MCF

MVGF

MVF

MVF+MVGF

GF

Figure 4.3: Effects of grants on government

expenditures in a federalist system

(a) (b)

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II. Two-party competition - deterministic

voting

With an increasing size of communities (polities), direct

democracy becomes unrealistic. Thus, decisions are taken

by representatives. These are assumed to behave

rationally and as utility maximisers.

Put differently: “…parties formulate policies in order to win

elections, rather than win elections in order to formulate

policies.” (Downs 1957, p. 28, cited after Mueller 2003, p.

230).

Three important aspects

• behaviour of representatives (campaign and office),

• behaviour of voters,

• outcome under representative democracy.

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Much of what we learned with respect to direct democracy,

also applies to representative democracy, e.g.

• median outcome,

• cycling,

• log-rolling.

a) Outcomes in the Hotelling-Downs-Model

The basic model is the Downs model.* However, the first to

analyse political competition in a spatial model was Harold

Hotelling.**

The easiest way to think of Hotelling’s model is to imagine

a western city with a couple of saloons. Where will you find

the saloons?

* Downs, Anthony (1957), An Economic Theory of Democracy, New York.

** Hotelling, Harold (1929), ‘Stability in Competition’, The Economic Journal, Vol. 39,

pp. 41-57.

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Figure 4.4: Median voter outcomes under two-party

competition

Number of

voters

Position of

candidatesL X RM

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Number of

voters

Position of

candidates

X MNumber of

voters

Position of

candidates

M

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The findings of Figure 4.4 (upper part) very much are

similar to the outcome under direct democracy (median).

However, the assumptions are unrealistic:

• one issue dimension (left or right),

• single peaked preferences,

• symmetric and unimodal preference distribution,

• all individuals vote,

• two candidate parties (the terms candidate and

party are used synonymously).

Two reasons may be responsible for a relaxation of the

assumption that all voters do vote:

• indifference and

• alienation.

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Then, still the median voter outcome holds, as long as the

preference distribution is unimodal and symmetric. The

median voter determines the outcome.

This may change if either preferences are asymmetrically

distributed (mid part of Figure 4.4) or if the distribution is

multimodal (lower pat of Figure 4.4).

In both cases, the degree of alienation is decisive; and in

both parts of the figure, it is too small to change the

median voter outcome.

Like in direct democracy, a problem of instability may arise

if the world is multidimensional, i.e. if a program

comprises of many issues.

Combined with multimodal preference distribution and

alienation, multidimensionality might cause that extreme

candidates win over the median.

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Again, log-rolling may arise, causing cycles.

Voters Issue 1 Issue 2 Issue 3

A 4 -2 -1

B -2 -1 4

C -1 4 -2

A candidate preferring all alternatives, maximises social

welfare.

However, a candidate preferring issues 1 and 2 and

preferring not issue 3 may win over the first one, as voters

A and C can gain at the expense of voter B.

Cycling, as every platform can be defeated.

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In a representative democracy, cycles should not be

observed in single elections, as individual candidates

cannot rotate within one campaign.

However, it should be observed in a permanent change of

government (revolving doors).

Alternative hypotheses:

• random hypotheses and

• conspiracy hypotheses.

In the US (the appropriate example for two-party

competition), the incumbent party left government only in

a fourth of the cases.

Why so much stability?

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b) Two-party competition in a constrained policy

space

Candidates may restrict their platforms only to a subset of

the policy space.

Imagine two parties and three voters (Figure 4.5) with

equally long contract curves. No point in the (x1,x2)-

diagram can defeat all others (see Figure 3.10).

It seems rational for candidates to restrict their platforms

to points close to the voters’ ideal points.

The restricted set of platforms is called the uncovered set.

These still can be defeated, but only in a cycle.

___

In figure 4.5, the uncovered set is the Pareto set ABC.

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A

B

C

x2

x1

Figure 4.5: Cycling outcomes for a

three-voter electorate

K

I

J

H

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Relaxing further assumptions

1) If candidates have personal preferences,

• they may only reluctantly remove policy positions,

• the number of dimension may be reduced,

• ideology may become the single dimension.

2) If candidates are not exogenously given, but can enter

and leave the contest, the result is similar. Under the

median voter outcome, it does not make sense to enter, if

one candidate has already declared her platform.

On the other hand, this relaxation shows that under two-

party elections both candidates will not have identical

platforms.

Empirical tests don’t support to the median voter outcome.

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c) Two-party competition (probabilistic voting)

A B

C

M

UA UB

UC

Figure 4.6: Cycling possibilities

x

y

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So far, we have assumed that the voters are easily caught

by and immediately react to the candidates’ moves (see

Figure 4.6). A slight change to the left wins certain votes

and loses others.

This “jerky” response by the voters is implausible:

• the voters are unlikely to be fully informed about

the candidates’ positions;

• the candidates may not know where the voters’

optimal points are;

• there may be random events having influence on

the voters’ decisions.

If we assume probabilistic voting instead of deterministic,

i.e. if voters behave continuously instead of

discontinuously, the median voter outcome is confirmed.

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The equilibrium is within the Pareto set, i.e. within the

triangle ABC. Therefore, the normative properties of the

equilibrium are desirable.

What happens if interest groups are introduced into the

analysis?

• The existence of interest groups implies a bias in

the probability of a candidate of being voted for

(see Figure 4.7);

• the candidates know the distribution of the bias

term, but not the individual bias;

• still, the Pareto set can be reached;

• however, different interest groups receive

different weights (welfare);

• “one man, one vote” does not hold any longer.

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0li ri bij

hi

Frequency

Figure 4.7: A uniform distribution of biases1. Introduction



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III. Multi-party competition

a) Selecting a representative body

Two party competition is not accounting for differences in voters’

preferences accurately multi party competition.

Imagine s groups with homogenous preferences each; in a

representative body there are s seats proportional

representation.

Each group sends one representative, so that all kinds of

preferences are represented in the assembly. If s still is too big,

then one could restrict the size of the assembly to m < s members.

Then m – s groups would not be represented. Alternatives

(additions) are

• runoff elections to sort out the number of votes

each of the m elected candidates has,

• randomised choice of m out of s representatives

relying on the law of large numbers.

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b) Proportional representation in practice

Political practise is still different. In general, it is a

compromise between geographical and at large

representation.

If more than one person per geographic district is sent to

the assembly in the election, a formula to translate votes

into seats in the parliament is needed.

Largest remainders rule:

q = v/s with v (s) = total number of voters (seats),

q = Hare quotient;

vp/q = I + f with vp = votes won by party p,

I = number of seats won by party p,

f = remainder.

The seats are assigned according to the size of I and high f.

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The d’Hondt method allocates the remaining seats (after

adding I) by repeated application of the largest

remainders rule.

Alternatives to the Hare quotient are the Droop quota d:

d = v/(s+1) or

d = [v/(s+1)] + 1;

and the Imperiali I:

i = v/(s + 2).

See Table 13.1 in Mueller (2003, p. 268).

If not parties but candidates are elected, the single

transferable vote (STV) can be applied.

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c) Electoral rules and the number of parties

Duverger’s law: under plurality rule, the number of parties

converges to two. To test this law, one can use the effective

number of parties based on the number of votes (ENV) and

the number of seats (ENS) a party receives respectively:

ENV = [(vp/v)2]-1, and ENS = [ (sp/s)2]-1.

Example Federal Election 9/22/2013

5 parties, 20 per cent of the votes each,

5 party system;

5 parties, 60, 30, 7, 2, 1 per cent of the votes respectively,

2 party system.

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L R0 1 3 5 7 9 10

Party A Party B Party C Party D Party E

20% 20% 20% 20% 20%

Figure 4.8: Party positions with a uniform distribution

of voter ideal points

d) The goals of parties

Two aspects (levels) are of relevance:

• position on the ideological spectrum

• decision on joining a coalition or forming a

cabinet after election

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L R0 1 3 5 7 9 10

Party A

Party B

Party C

Party D

Party E

10% 20% 24% 30% 16%

Figure 4.9: Party positions with a nonuniform

distribution of voter ideal points

It is very difficult to say theoretically how both aspects

are dealt with in politics. Parties tend to settle into certain

ideological positions and remain there (empirical

observation).

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A B C D E F G

15 28 5 4 33 9 6

If a single party does not hold an absolute majority, a

coalition is necessary. There are 61 possible coalitions

that form a majority in the above scenario.

A coalition is called a minimal winning coalition if the

removal of any one member (party) is changing it into a

minority coalition. These are:

BE, ABF, ACE, ADE, AEF, AEG, ABCD, ABCG, ABDG,

CDEF, DEFG.

A minimum winning coalition contains the smallest

number of seats of all minimal winning coalitions (CDEF).

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Not all of the eleven possible coalitions are equally likely

to start existing.

First, smaller coalitions with respect to the number of

parties are easier to run, as negotiations take shorter time

and as the probability of survival is higher.

Second, there should be an ideological closeness of the

coalition members. This minimal connecting winning

hypothesis reduces the number of likely coalitions to four

(ABCD, BCDE, CDEF, DEFG).

Trade off between these two hypotheses.

Another important aspect is the number of dimensions.

With more than one issue, cycling becomes possible,

coalitions may become unstable.

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IG

IS

IF

ICCC

FF

GG

SS

G C

C F

Economic Policy

Foreign

Policy

Figure 4.8: Cabinet formation in the German Bundestag

in 19871. Introduction



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Figure 4.11: Determinants of cabinet stability

Number of parties

Number of

representatives

elected per

district

Number of issue

dimensions

Ethnic, religious and

ideological diversity

Cabinet stability

e) Cabinet stability1. Introduction



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f) Strategic voting

Why do the Free Democrats in Germany always stay in

the Bundestag, but regularly miss to meet the 5 per cent

threshold in the state parliaments?

S C F

49 47 4

49 41 10

The voters of the Christian Democratic Party have

regularly voted strategically (mainly before the

appearance of the Green Party) to ensure a victory of the

conservative spectrum over the Social Democratic Party.

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IV. The paradox of voting

“…Thus the typical citizen drops down to a lower level of

mental performance as soon as he enters the political

field. He argues and analyzes in a way which he would

readily recognize as infantile within the spheres of his real

interest. He becomes a primitive again…” Joseph

Schumpeter, quoted after Mueller (2003, p. 303).

Schumpeter concludes that human beings would relax

their moral standards and give in to prejudices in the

political arena.

Is Schumpeter right?

How rational is the voter?

And why does she vote anyway?

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)1(22

32)

2

1)(1(2

N

eP

pN

© Freytag 2015 44

a) The rational voter hypotheses

A rational voter will vote for the party (candidate)

according to the own expected utility derived from this

candidate’s victory (difference B between the expected

utilities of both parties victories).

It is unlikely that an individual voter’s vote is decisive

(from an individual perspective).

The formula 4.1 shows the probability that an individual

voter decides the election.

4.1

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When p = 0.5 and N = 100,000,000 P = 0.00006;

when p = 0.5 and N = 50,000,000 P = 0.000085.

P decreases with p deviating from 0.5.

Given that the probability to be run over by a car while

going to or coming back from the election, is higher than

P, one wonders why people do vote.

Three explanations can be thought of:

• redefinition of rationality,

• relaxing the rationality assumption,

• relaxing the self-interest assumption

Changing rationality can imply a taste for voting, cat and

mouse, and minimising regret instead of maximising

utility.

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Empirical evidence for the rational voter hypothesis

One votes, if PB + D – C > 0,

with D being the benefit from the act of voting and C

being the cost of voting.

For an empirical estimation of the hypothesis we define

R = PB + D – C, to answer the question “Did you

vote?” The literature uses 5 groups of variables:

• personal characteristics,

• cost variables (C),

• strategic value of voting (P and B),

• interest in campaign (D),

• obligation to vote (D).

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Study Sample and time period P B D C E Y

Riker and

Ordeshook, 1968

4,294 questionnaires

(quest.), 1952, 1956,

1960, U.S. presidential

elections (p.e.)

+ + +

Brody and Page,

1973

2,500 quest., 1968 p.e. 0 +

Ashenfelter and

Kelly, 1975

1,893 quest., 1960,

1972, U.S.-p.e.

0 + + - + +

Silver, 1973 959 quest., 1960 U.S.-

p.e.

0 +

?

+

?

- +

Frohlich,

Oppenheimer,

Smith and Young,

1978

1,067 quest., 1964 U.S.-

p.e.

+ +

?

+

?

-

?

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Table 4.1: Summary of studies testing the Downsian

model (with extensions) using survey data1. Introduction



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Study Sample and time period P B D C E Y

Perry, Moser and

Day, 1992

~1600 quest., 1984 and

1985 U.K. national and

local elections

+

?

+

?

- 0

Matsusaka and

Palda, 1993

2,744 quest., 1979 and

1980 Canadian national

elections

0 + 0

Knack, 1994 4,651 quest., 1984,

1986, 1988 U.S.

national elections

+ + +

Greene and

Nikolaev, 1999

~21,000 quest. 1972-

1993 U.S. elections

- + +

Thurner and

Eymann, 2000

1,400 quest., 1990

German national

election

+1

© Freytag 2015 48

P,B,D,C are proxies for main components of Downsian model;

R = PB + D – C; E stands for education level and Y for the income of the voter.1Thurner and Eymann test whether perceived differences in party positions on key

issues increases the likelihood of the respondents voting. Only for immigration

policy was a significant effect found.

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b) The expressive voter hypothesis

Relaxing the rationality assumption, leads to the

expressive voter hypothesis.

Instead of aiming at a certain result, the voter wants to

express an opinion of how the outcome of the election

should be;

the outcome of the election is the same as in Downsian

model.

The motivation is different. However, the result then can

also be changing:

irresponsible voting.

The hypothesis stands in contrast to strategic voting.

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c) The ethical voter hypothesis

Relaxing the self interest assumption, leads to the ethical

voter hypothesis.

The voter is seen as both ethical and selfish (Jekyll-and

Hyde view):

Oi = Ui + θ Uk with k ≠ i and 0 ≤ θ ≤ 1.

d) Voting as duty

Voting is seen as a sense of duty no theoretical

explanation. Behavioural psychology offers an explanation

for θ > 0 . Individuals learn that voting is sensible.

Therefore, ethical voting is indeed selfish.

Tautology?

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V. Rent seeking

a) The basic model

Difference between rents and profits:

Entrepreneur profit seeking,

Lobbyist rent seeking.

Rent seeking is an activity to generate income without

efforts on markets for goods and services. These cause

socially wasted expenditures (social costs):

• expenditures of potential recipients,

• expenditures of third parties suffering from the

successful rent-seeking,

• efforts of governments associated with rent

seeking.

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Figure 4.9: The social costs of

monopoly with rent seeking

MC

Price

Quantity

R

L

Pm

Pc

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rRn

nI

TI

RIrI

TI

RrI

IRTI

IGE

If

IfI

r

rr

r

r

r

r

n

jjj

ii

ii

2

2

11

1

)1(

01)(

)(

)(

)()(

© Freytag 2015 53

The basic rent-seeking model with a fixed number of players

(1)

(2)

(3)

(4)

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rn

n

R

nI

rRn

nrR

n

nnnI

rn

n

)1(

)1()1(

1

2

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The basic model with diminishing or constant returns, r ≤ 1.

(5)

(6)

(7)

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b) Rent seeking through regulation

The normative grounds for regulation are cases of market

failure (chapter 2).

Market failure is regularly combated by taxes, subsidies

and regulation.

In addition, one finds many cases of regulation not

justified by market failure (state failure).

A utility maximising government will set a price (price

regulation) so that the marginal gain in support by the

rent-seeking group equals the marginal loss in support by

the consumers.

Therefore, the main beneficiaries of regulation are the

regulated firms (plus the regulatory office (see section 4.f).

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One interesting implication is that the prices are between

competitive prices and pure monopoly prices (as the latter

would increase the loss in support by consumers above

the gain in support by the very industry).

Valuable explanation of agriculture protection and

taxicab regulation around the world.

Environmental regulation can be explained by this theory,

e.g. pesticide regulation and the number of listed species

by individual state in the Endangered Species Act in the

US.

Becker (1983, 1985) shows that the rent seeking process

can be reverted. If the costs for the consumers (or the

suffering group) increase, their rent seeking activities also

increase, and the government starts a new calculus.

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c) Rent seeking through tariffs and quotas

To explain rent seeking in international trade, the Ricardo-

Viner-model with specific factors of production is adequate.

All factors employed in the country’s sectors with

comparative disadvantages lose by a change from autarky

to international trade.

Therefore, the whole industry invests into rent-seeking

activities. The calculus of the government includes again the

marginal gains and losses in support by the industry and the

consumers plus the effects of certain instruments of

protection on the international trade policy agenda.

As quotas have always been forbidden, VERs were

introduced, giving the exporting country the chance to get

the rents; after 1994, VERs also have been prohibited.

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Study Economy Year Welfare loss

Krueger (1974) India 1964 7% GNP

Krueger (1974) Turkey 1968 15% GNP

(trade sector)

Posner (1975) United States various 3% GNP

(regulation)

Cowling and Mueller

(1978)

United States 1963-9 13% GCP1

(private

monopoly)

Cowling and Mueller

(1978)

United

Kingdom

1968-9 13% GCP

(private

monopoly)

Ross (1984) Kenya 1980 38% GNP

(trade sector)

© Freytag 2015 58

Table 4.2: Estimates of the welfare losses from rent

seeking.1. Introduction



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Mohammad and

Whalley (1984)

India 1980-1 25-40% GNP

Laband and

Sophocleus (1988)

United States 1985 50% GNP

Lopez and

Pagoulatos (1994)

United States 1987 12,5%

domestic

consumption

Study Economy Year Welfare loss

© Freytag 2015 59

1GCP=gross corporate product

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d) The logic of collective action

How can we explain that some interest groups are more

successful than others in a) organising themselves and

b) obtaining rents in politics? Both questions can be

answered with:

• rent-seeking as collective (club) good free

riders,

• opportunity cost of rent seeking.

In addition, interest group formation can be enhanced

by:

• additional private goods offered by the group,

• obligations to join a group,

• different size of group members.

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VI. Bureaucracy1. Introduction



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The bureaucracy is a part of the supply side of the

political market.

The term bureaucracy has a negative connotation – the

static and conformist bureaucrat is seen as the antipode

to the dynamic entrepreneur. We use the term without

this connotation, as we want to explain the bureaus’

performance with rational behaviour and do not want to

judge them morally.

a) Budget maximization

Bureaus are budget maximizers, as income is fixed.

Bureaucrats pursue power; a basic foundation of power

is superior information PAP.

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The output of bureaus has a non-market nature. The buyer

cannot observe the quality, as market prices do not exist.

In addition, there is a bilateral monopoly between bureau

and sponsor (government).

Output is too large and probably not efficiently produced.

Instead of the optimal output of the benefit maximising

sponsor satisfying B’ (Q) = C’ (Q), the bureau’s output is too

large satisfying B (Q) = C (Q).

At this point social surplus is zero (E = F).

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)(')('

)()(

)('1

)('

))()(()(

0'',0'),(

0'',0'),(

QCQB

QCQB

QCQB

QCQBQBO

CCQCC

BBQBB

B

(1)

(2)

(3)

(4)

(5)

(6)

The basic model: budget maximising bureaucrats1. Introduction



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Figure 4.10: The oversupply of a bureau‘s output

B‘, C‘

E

C‘

B‘s

F

Q0 Q* Qs Q

B‘

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'1

)(

1

0

dP

dQ

Q

P

PBO

dP

dQ

Q

P

dP

dQPQ

dP

dB

PQB

© Freytag 2015 66

Extensions of the model: alternative

institutional assumptions.

(7)

(8)(9)

(10)

(11)

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Figure 4.11: Options for a price setting bureau

Q

P

PH

P1

Q1

C‘H

C‘L

η>1

η=1

η<1

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Alternative behavioural assumptions

So far, we assumed excessive but efficient supply of the

public good. It may also be possible that the bureaucrats

have additional objectives, e.g. the increase of personnel,

the size of the office space etc.

c) Slack maximization

X-inefficiency or bureaucratic slack slack-maximising

bureaus

It is difficult to measure efficiency of bureaus data

envelopment analysis to calculate the efficiency frontier

and compare it with the actual outcome.

In Figure 4.15, the distance between BE’ (the efficiency

frontier) and BS’ the actual outcome would be the result.

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Figure 4.12: The output choice of

a slack-maximizing bureau

QB

Z

E

S

B

Y

E‘

S‘

Z‘

QS QZ

Umax

Umin

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Empirical evidence:

Whether or not bureaucrats are able to maximise their own

objectives, depends among others on the discretionary

leeway they have agenda setter or not?

d) The power of the agenda setter

If they are agenda setter, they may force the sponsor to

approve a much higher than optimal budget.

Oregon school budget referendum process:

By offering two alternatives below and above the maximal

utility of the median voter, the school bureaucracy

managed to receive a higher budget than in the median

voter’s optimal position (Figure 4.16).

Comparison between privately and publicly provided

services (Mueller 2003, pp. 373-380).

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GrGm Gb G

Median voter‘s

utility

Figure 4.13: Options for the budget

maximising agenda setter1. Introduction



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Comparison between publicly and privately provided

services (Mueller, 2003, pp. 373-380)

20 sectors are subject to the comparison:

1) Airlines

2) Banks

3) Bus and transit service

4) Cleaning services

5) Debt collection

6) Electric utilities

7) Fire protection

8) Forestry

9) Hospitals and nursery services

10) Housing

11) Insurance business

12) Ocean tanker repair and maintenance

13) Railroads

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14) Refuse collection

15) Saving and Loans

16) Schools

17) Slaughterhouses

18) Water utilities

19) Weather forecasting

20) Industrial companies

In general, private provision is more efficient and

saves costs for the public!

Public firms invest more; higher capital intensity.

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e) The Government as Leviathan

One can even extend the model in that sponsor and

bureau is interpreted as one joint unit ”monolith

monopolist”.

Government in this view is looked at as a malevolent

budget maximizer rather than a benevolent public good

provider.

If this view has a point, a the normative solution is to

reduce discretionary power of governments by means of a

constitution veil of uncertainty.

Figure 4.14 shows that the Leviathan would impose a

higher tax on the citizen if he is free to choose.

Consequences for the theory of optimal taxation!

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Figure 4.14: Alternative strategies for

taxing income and leisureEarned

Income

Leisure

BH D

A

C

G

U1

U2U3

E

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Government as Leviathan – empirical evidence

The empirical literature has focused on the systems of

checks and balances:

• constitutions constrain the legislature,

• federal structures are opposing huge

governments,

• application of the subsidiary principle diminishes

government size,

• intergovernmental competition does alike,

• government collusion (log-rolling on the EMU

level) increases government size.

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f) Regulatory capture*

Bureaus do not only provide public goods. They also are

responsible for regulation in the case of market failure.

As shown above, the regulated sector normally benefits

from regulation; prices are between competitive and

monopolistic outcome.

Therefore, it makes sense for interest groups to stay in

close contact with the regulatory office.

At the same time, the regulatory office gains its status only

by regulation. It is not in its interest to give up regulation,

even if market failure cannot be observed any longer.

* Stigler, George J. (1971), The Theory of Economic Regulation, The Bell

Journal of Economics and Management Science, Vol. 2, S. 3-21.

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It is sensible to assume the position of the regulated

industry.

The bureau is captured by the industry. Consequences

include longer and heavier regulation than needed for, job

offers for regulators in the very industry.

Potential examples:

Coal mining industry Ministry of Economic Affairs

Telecommunication incumbent communication regulator

Insurance industry financial regulator

Utilities energy regulator

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